Listing of exchanges opposed

Mumbai: The Bimal Jalan-headed committee that was set up by the Securities and Exchange Board of India (Sebi) to review the structure of market infrastructure institutions (MIIs) such as stock exchanges, clearing corporations and depositories, has proposed that such entities be prohibited from getting listed.

The proposal, if accepted, may hurt the businesses of such entities and prevent new entrants from drawing investors as shareholders may find it difficult to exit their holdings with sufficient gains in the absence of a public offering.

The panel says such entities should not become a vehicle for attracting speculative investments.

“Further, MIIs being institutions, any downward movement in its share price may lead to a loss of credibility and this may be detrimental to the market as a whole," it said.

To ensure that MIIs maintain the required transparency and corporate governance norms, the panel suggested that listed company standards be applied to them, with the information posted on the website.

At present, there are two national-level exchanges for trading in equities—the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). MCX Stock Exchange Ltd (MCX-SX) is seeking Sebi approval to enter the space. MIIs also include clearing corporations and the two depositories.

Any entity seeking to be listed will require prior approval from Sebi if 24% or more of its equity is held by that stock exchange or by an MII in which the bourse holds shares. While the listing of an MII provides an exit route to shareholders, it opens up more conflicts of interest for the stock exchange, according to the panel.

MCX-SX was critical of the recommendations.

“We fail to understand that when the banking and insurance sectors, which are more critical than exchanges in an economy, are allowed to raise capital from listing and also have more competition, then why a case is being made for lesser competition in stock exchanges and then it is being recommended that stock exchanges may not be able to raise capital from market," said Joseph Massey, managing director and chief executive officer of MCX-SX. “This will prevent new entrants in the exchange space."

Among various issues, the panel examined aspects of MIIs such as ownership patterns, corporate governance norms, relationships between them, board structures, employee compensation, net worth requirements, and promotion and sponsorships in MIIs and so on.

The panel supported the concept of an anchor investor for stock exchanges. This could be a financial institution or a banking company with a net worth of at least ₹ 1,000 crore, with a holding of up to 24%, on condition that such an investor brings down its stake to 15% in 10 years.

The combined holding of all anchor investors in a stock exchange can be as much as 49%, the panel proposed.

“Allowing an institution to hold up to 24% stake will help new stock exchanges to attract more investors and establish themselves. This was not allowed for (in) the existing exchanges when they were formed," said an industry official on condition of anonymity.

At present, institutions such as stock exchanges, depositories, clearing corporations, banks, insurers and public financial institutions are allowed to hold up to 15% in a stock exchange.

The committee further suggested that clearing corporations and depositories should not be allowed to invest in stock exchanges as this wouldn’t benefit the market.

The panel also suggested restricting the holding of a stock exchange in a depository at 24%. At present, a stake of as much as 51% by sponsors, including stock exchanges, is allowed in depositories.

The panel’s proposal, if implemented, will require all the stock exchanges to bring down their stakes in the two depositories. NSE holds 25% in National Securities Depository Ltd, while BSE has a 54% stake in Central Depository Services (India) Ltd. The panel suggested that the stock exchanges may be given three years to cut their stake to 24%.

“The committee recognizes that stock exchanges and depositories both have a surveillance and regulatory function. For obvious reasons, one surveillance mechanism desirably should not be in control of another surveillance mechanism," the report said.

For clearing corporations, the committee recommended at least a 51% holding by one or more stock exchanges. NSE has a 100% owned subsidiary, National Securities Clearing Corp. Ltd, for clearing and settlement services, while BSE has an independent 100% owned clearing corporation, Indian Clearing Corporation of India Ltd, for some of its segments. MCX-SX too has set up a 100% owned subsidiary, MCX-SX Clearing Corp. Ltd, for clearing and settlement.

“While private participation is permitted for stock exchanges, it is felt that clearing corporations, being at the core of the settlement system, must continue to be promoted by stock exchange(s)...," the committee said.

In order to enhance corporate governance in MIIs, the panel recommended that no trading or clearing member should be allowed on the board of any of the stock exchanges and the number of public interest directors (PIDs) on the board of a stock exchange shall be at least equal to the number of shareholder directors without trading or clearing interest.

The sitting fees payable to the PIDs should be as per the Companies Act, 1956, and they should not be paid any commission.

Currently, stock exchanges are allowed to have up to 25% of the board as trading member directors, a minimum of 25% as PIDs and the balance as shareholder directors.

“Trading members on the board of a stock exchange are privy to confidential information. This, therefore, can give rise to conflict of interest when the entity regulated by the stock exchange is also on the board of the stock exchange. Conflict of interest also arises when shareholders with commercial motives form a majority in an entity, which also has regulatory functions to perform," the panel said.

However, the panel felt that stock exchanges should have an advisory committee separately, constituting some trading members. Trading members will not be permitted participation in any other committee of the exchange.

“The report advances more arguments to preserve the current market structure and, in fact, further reinforces its continuation despite the fact that we do not have a well-developed capital market with a full range of products and services and also we are underpenetrated," said Massey of MCX-SX.

“These recommendations, if accepted, would continue to protect the monopolistic market structure and the perverse anti-competitive practices adopted by some," he added.

The panel further said that MIIs should be considered public utilities and not be permitted to make unreasonable profits.

“The MII should levy reasonable charges on its users without abusing its monopoly or regulatory position," the panel said.

At the same time, the committee proposed that stock exchanges should maintain a net worth of ₹ 100 crore at all times, while clearing corporations should have a net worth of ₹ 300 crore.

At present, a net worth of ₹ 100 crore is required for depositories and setting up a new stock exchange. A similar net worth requirement of ₹ 300 crore is being contemplated for clearing corporations as well.

“In the event of a major default, if the clearing corporation is unable to meet its obligations, it could lead to a systemic collapse of the financial market. Keeping in view the clearing and settlement function, a need is felt to prescribe a higher net worth requirement for clearing corporations, as compared to stock exchanges and depositories," said the report.

Another key suggestion of the committee is aimed at setting compensation for top management at MIIs.

The panel said that the remuneration of key management personnel, including the managing director, chief executive officer and executive director should be decided by a remuneration committee appointed by board executives. This should be a fixed sum without any variable component linked to the commercial performance of the MII, the report said.

Further, their compensation should not in any way be equity linked. “It should also be ensured that the remuneration is determined after giving due regard to the industry standards for the same," the report said. At present, there is no such restriction on compensation of key officials at MIIs.

Sebi is seeking public comments on the report by 31 December, before finalizing the suggested changes.